What to Watch When PayPal Reports Earnings

By John Ballard Markets Fool.com

IMAGE SOURCE: PAYPAL HOLDINGS INC.

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When PayPal(NASDAQ: PYPL) releases its fourth-quarter earnings report on Thursday, January 26, investors shouldn't expect any surprises. PayPal has been a very consistent, growing its business for a long time, and its strong momentum should have continued through the holiday season.

Here's what to watch

As I wrote about in a previous article, the most important numbers to watch are active customer accounts and transactions per active customer account. Active accounts increased 11% year over year to 192 million in the third quarter, and PayPal processed 30 transactions per active account, an increase of 13% year over year. We're focused on the long term as Foolish investors, but any further acceleration in either of these metrics could serve as a catalyst to send the stock higher in the short term.

A steady flow of new features that allow users to more easily use their PayPal digital wallets have been fueling growth in total payment volume (TPV), which increased 28% to $87 billion in the third quarter. Management expects continued growth of around 25% over the next three years. PayPal's TPV growth has been clocking in close to 30% through 2016.Look for continued growth at or above the target of 25%. Anything less than that will be disappointing.

Management should provide further information on the recently announced partnerships with Discover Financial Services, Citigroup, and Fidelity National Information Services. Recently, management raised its three-year outlook for revenue growth from 15% to a range of 16%-17% largely because of partnerships with credit card issuers and banks.

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Another point of interest to investors will be Venmo. The peer-to-peer (P2P) payment provider is growing at a phenomenal rate, to the tune of over 100% year over year. It's on pace to process around $20 billion in annual payment volume. Venmo is facing greater competition in 2017 from ClearXchange, a P2P service owned by major banks. PayPal's service is very popular among millennials, who seem to be averse to doing business with big banks, so don't expect competition to cut into Venmo's growth. Look for Venmo to continue its momentum in 2017.

Another small, but fast-growing contributor to PayPal's revenue is Xoom. One area that should be addressed on the conference call is progress on cost controls. Since Xoom was acquired, it has been a drag on PayPal's margins. Management expects Xoom to begin contributing to earnings in 2017.

Also, management has recently talked about shifting to an asset-light business model where more of its consumer loan products, like PayPal Credit, will be financed by third-party providers. We may hear more updates on that progress, and most importantly, an idea of how much cash will be saved going forward.

Management evaluates the business' profitability based on cash generation, so investors should put more weight on growth in free cash flow as opposed to Wall Street's favorite -- earnings per share. Free cash flow is expected to be $2.2 billion for the full year 2016. Management expects free cash flow to grow in line with revenue -- 16% to 17% -- over the next three years.

One last thing

Finally, investors should watch how management characterizes current business trends looking ahead to the new year. Given PayPal's current momentum, analysts will be paying particular attention to guidance going forward. The company is facing more competition than ever, and positive comments about its current momentum and outlook would be very reassuring to investors about the durability of PayPal's competitive position.

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John Ballard owns shares of PayPal Holdings. The Motley Fool owns shares of and recommends PayPal Holdings. The Motley Fool has a disclosure policy.